Commodities offer a buffet of investing options

How to invest in the agriculture boom with futures, stocks and ETFs

NEW YORK (MarketWatch) -- The signs of concern are everywhere, from food riots in some nations, to empty tractor showrooms in the U.S. heartland, to sticker shock in the aisles of local grocery stores. Demand for agricultural items is outstripping supply.

Along with that concern, as always, comes opportunity for investors. While there's talk of a commodities bubble, which will eventually bring down the highflying sector just like tech stocks and mortgages before them, true believers have many ways to invest in the boom.

There are three main avenues to invest in commodities:

Futures and options: This is the traditional way in which commodities have been traded for years in the world of large-scale producers and end users.
Individual stocks: If investors think more tractors and seeds are needed to grow food, they will invest in the companies that make and sell those products.
Exchange-traded funds and notes: If there's a hot investment theme, you can bet that ETFs and ETNs are involved.

We've all seen pictures of the manic futures pits at the world's commodities exchanges, such as the Chicago Board of Trade and the New York Mercantile Exchange, where global prices are set by the biggest users and producers of goods like corn and soybeans -- the staples of the food production chain.
Individuals can take part in that activity, but experts regard it as the riskiest and most expensive way to invest in commodities.

Futures generally require you to make a fairly large up-front investment and to keep a margin balance on account with the exchange. If the price of your position fluctuates dramatically, which often happens with commodities, you would have to add to your margin balance.

"Futures can have unlimited risk," said Kevin Kerr, a commodities trader and founding partner of Kerr Trading International. "Futures can get expensive."
Instead, Kerr suggests that investors who want direct access to commodities markets use options, which are generally less expensive to trade than futures.
"Options on grains present limited risks," he said. "Buying options is best way to go."

Options on commodities futures, like options on equities, limit the downside by giving you the option to buy or sell the underlying commodities. With futures, you are committed to buy or sell at the set future date, at whatever the current price is.

There are also so-called "minis" on corn and soybeans, he added. Those are options that are a fraction of the size of the full option contracts used by the biggest players and therefore cost less to buy.
Even so, he said, buyers of options in the commodities markets should only risk money they are prepared to lose. Options have become more expensive as grain prices surge.

"Outright options prices have gone up for corn and soy," Kerr said. "Often we will do an options spread."
In an options spread, you would buy options for some future date, while at the same time writing, or selling, options to other investors. That way, you could partially fund your options purchase, reducing the cost as well as the risk.

Kerr is most bullish on grains this year, suggesting that a late start to the growing season, skyrocketing production costs and demand for ethanol feedstock will drive prices higher.

"Corn is likely to be strong," Kerr said. "Even if yields are high, there will be shortages."
Individual stocks

Kerr also invests in stocks, and he says that with corn and other crops at current levels, agriculture stocks are doing great.